Why the ugly duckling of energy still matters

January 18, 2016 | Kim Iskyan

Few commodities have had a worse time in recent years than coal. The price of coal is down 65% from all-time highs – and even down 25% from 2008-2009 global economic crisis levels. Coal is being replaced by cheaper, cleaner sources of energy. And about two-thirds of coal production loses money for coal mining companies.

But coal isn’t going anywhere. It still accounts for more than a third of power generation in the U.S., two-thirds of energy production in China, and close to half in India. Without coal, a lot of the world would be cold and in the dark.

Coal prices reached all-time highs just five years ago, when growth in Chinese energy demand was at its peak. But a lot has changed since then.

Coal prices have fallen in part because of lower demand from China, the U.S., and India, the three largest consumers of coal. China, which is by far the world’s biggest coal consumer, accounted for nearly all of the growth in coal demand from 2000 through 2015. But that growth has reversed. In the first half of 2015, China’s coal usage actually fell by 3.5%.

That’s not just slower demand. It’s an absolute decline, largely because of the Chinese government’s efforts to reduce pollution, which threatens to become a political problem. Hundreds of coal plants have been closed, and those still open are operating at much lower levels. Coal is being replaced by cleaner renewable sources of energy.

Coal demand in the U.S., which is ahead of China in its focus on cleaner sources of energy, has been dropping for a while. Tougher environmental restrictions have led to a shift in demand towards cheaper and cleaner natural gas. Coal’s share in U.S. power generation was around 55% in 2000, while the natural gas share was just above 15%. Today, natural gas has surpassed coal, and coal now accounts for only 36% of power generation.

In India, coal imports have fallen by more than a third. That’s partly because the country is using more coal mined in India. But the level of operation (called the utilisation rate) of coal plants has declined sharply, showing that people are using a lot less coal to generate electricity.

Meanwhile, production of coal has fallen – but not by nearly enough to make up for the drop in price. Similar to what’s happening with oil, there’s more coal being produced than there is demand.

Making matters worse for coal is a global “divestment” movement, which encourages investors to stop financing activities that lead to higher greenhouse gas emissions – and burning coal is the biggest contributor to man-made carbon dioxide emissions. Divestment is when financial support is removed from specific companies or industries (by, for example, selling shares) to promote certain policies. According to the Financial Times, investors who control US$2.6 trillion in investible assets (such as Norway’s state pension fund) have said they will cut back or completely sell holdings in coal and other fossil fuel companies.

This is similar to when investors refused to own shares of companies that did business in apartheid South Africa in the 1970’s and 1980’s – as a way of pressuring South Africa to change its race policies. Or, in recent years, it’s like investors avoiding tobacco stocks due to the health effects of smoking.

But unlike tobacco – which is addictive, so there will always be a demand – there are plenty of substitutes for coal.

What’s more, the recent Paris climate agreement, which was signed by nearly 200 countries, calls for big cuts in carbon emissions from burning fossil fuels. Cheaper, cleaner and renewable sources of energy will replace coal over time.

But in the meantime, coal will remain a vital source of energy for billions of people. For example, China’s demand for coal is declining, but coal will still remain a central part of China’s energy production for decades to come. It’s the same thing in India — and in much else of the world.

Meanwhile, low coal prices might solve themselves. China’s ban on new coal mines until 2019 will help reduce supply. The second-largest coal producer in the U.S., Arch Coal, filed for bankruptcy last week, the latest in a string of coal miners to go bust in recent months. More are sure to follow, as only one-third of coal production is profitable at current price levels. This means that supply will fall, and the price of coal will eventually find a floor.

That might not happen for a while. But a key ingredient of modern civilization isn’t going to be in terminal price decline forever.

When the time comes to speculate (this wouldn’t be an investment: it’s a speculation) on a recovery in the price of coal, the coal mining companies that still exist might be attractive investments. You can also buy a portfolio of coal mining companies using the Market Vectors Coal ETF (ticker KOL on the NYSE). This exchange traded fund gives you exposure to a basket of companies that get more than 50% of their revenue from coal mining.

About Kim Iskyan

Kim Iskyan has nearly 25 years of experience as a stock analyst, hedge fund manager, political risk consultant, and financial commentator in more than half a dozen emerging and frontier markets.

SUBSCRIBE NOW

As a relatively new subscriber to your Asian Investment Daily, I want to thank you for the exceptionally well-written articles. Your articles are invariably easy to understand, logical, and informative”